Guest Post by PlanetNL
PlanetNL7 – Can Muskrat Float After a
Bailout
In prior PlanetNL
postings, Muskrat economics have been shown to be unaffordable to consumers and
a major threat to the solvency and survival of the Government of the
Province. Write-offs are a certainty and
there may be many who think the project might look good after that.
Equity write-downs and restructuring
of unmanageable debt are well known practices in the corporate world. Does Muskrat have the potential to avail of
such opportunities and would operations then make economic sense?
The massive spreadsheet
behind PlanetNL3 entitled "Muskrat Falls Subsidies Will Cause Gov't Debt Spiral" is employed again to create a series of charts to tell the
story. The fundamentals are the same: two
Nalcor ATIPPA information releases provide cost and revenue breakdowns of the massive
Power Purchase Agreement and the Nalcor forecast of Dividend and Export
Revenue.
Unlike Nalcor, this
analysis considers consumers ability to pay and how much power they are likely
to use after massive price increases. Nalcor
predicts that electricity sales will not substantially decrease when price
potentially more than doubles, but this is irrational propaganda. Many Newfoundlanders will substitute away
from electric resistance heating to something else or simply dial back their
usage. Virtually everyone will find
other ways to reduce consumption of non-heating electricity as well. This analysis assumes a near-30% drop in
energy sales from 7000 GWh down to 5000 GWh.
Dissection of the Power Purchase
Agreement
Shown below is the
50-year Power Purchase Agreement needed to pay for Muskrat broken down into its
primary cost categories [source: Nalcor data].
The biggest slice is the heavily backloaded Return on Equity. Depreciation is a constant 2% of capital cost
per year.
Interest costs are, as
typical, high early and decreasing over time.
These 3 elements are the principal areas targeted in a “write-off” of equity
and debt.
As step one, equity and
depreciation are removed. Keep in mind
this means that the Province’s $4.0B equity contribution is a complete loss and
Emera’s $800M in equity must go as well.
When an asset is written
down in value, future depreciation must also be reduced. As the conclusions will show, Muskrat will
never plausibly make any money therefore the asset is worthless and there is
nothing to depreciate.
The chart below still
contains more PPA costs than available revenue, so the next required step is
for Ottawa to assume full responsibility for the $5.0B Federal Loan Guarantee signed
off by former Prime Minister Harper in 2012 and for the $2.9B approved by
current Prime Minister Trudeau in 2016. This
removes interest costs.
At this point, costs
are stripped down about as bare as may be reasonably possible. The relatively small Water Power Rental costs
could be construed as being ROE-like Provincial revenue, however, leaving it in
does not change the analysis much and it may be argued this amount is a small
contingency for unforeseen costs (for example, a source of revenue to provide electricity
bill support to many low income people who are going to have serious problems
with the steep rate hikes).
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Related to this Post:
Chernobyl-Lite: The Price of Denying Muskrat Economics
Chernobyl-Lite: The Price of Denying Muskrat Economics
Muskrat Subsidies Will Cause A Gov't Debt Spiral
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Available Revenue – Increased Ratepayer Billings and Exports
As presented in PlanetNL3,
two key simple broad-stroke assumptions for estimating ratepayer contributions
are (1) energy sales held flat at 5000 GWh and (2) energy price set by the
Premier’s publicly stated goal in 2017 for a domestic price of 17 c/KWh in 2021.
The energy price is escalated by 2% inflation annually thereafter. After deduction of non-Muskrat NL Hydro and
Newfoundland Power costs, surplus ratepayer cash flow available to pay the
Muskrat PPA is calculated and shown as the main component of the chart below.
Energy export revenues
are shown exactly as specified in Nalcor projections. While more energy is sure to be available for
export, Nalcor’s export profit margins are prone to severely decrease – the two
issues likely negate each other and therefore no changes to export revenue are
made.
Net Earnings After Write-Offs
Finally, the net
earnings are calculated by taking the Muskrat revenue and subtracting the
revised PPA costs (two charts above). The results are a mixed bag.
Some positive net
earnings potential in the first 20 years indicates that the energy pricing in
the model is a little too high. This
would be corrected by holding the price flat at 17 c/KWh until 2029 and only adding
some inflation after that. This spells
some minor relief for consumers who will still be seriously hurting from the steep
rate hike from 9.7 c/KWh in mid-2016 up to 17 c/KWh in 2021.
The growing losses in
the final 20 years will demand price increases greater than the assumed 2% per
year during that period to achieve breakeven.
Is This Good?
Breakeven is a generous
term because heavy baggage has simply been shifted elsewhere. The Province has to deal with its $4.0B in
unrecoverable equity. Emera must lose
its $800M equity. Ottawa has to take on
$7.9B. None of these things are good and
indeed they leave considerable room for very ill after-effects.
Breakeven also depends
on Nalcor’s Operation and Maintenance cost assumptions proving correct and that
the quality of the assets is everything they hope it is. If costs rise, NL consumers are asked to pay
more.
The model also doesn’t
consider other risks that Nalcor disavows including the strength and longevity
of the North Spur, the long transmission lines designed to somewhat modest
storm criteria, and a dubious Water Management Agreement contested by Hydro
Quebec and still before the courts.
Also consider, this
massive Newfoundland energy project isn’t turning out to be for Newfoundland
energy needs after all. Once decreased
energy demand becomes a reality in this Province, Muskrat Falls may be
completely unnecessary to the energy requirements of this province. The project will prove to be all about meeting
Nova Scotia’s energy needs. What started
out as an agreement where Nova Scotia would receive 20% energy for a 20%
cost-share is morphing its way toward 100% energy to Nova Scotia for their 20% cost
(or possibly less).
As presently
constructed, the Muskrat contracts with Emera have Newfoundlanders paying
nearly the entire shot for benefits that accrue exclusively to Nova Scotians. The economics of export beyond Nova Scotia has
become infeasible while Nova Scotia has the potential need for the entire
output of Muskrat all by itself for most of the year to offset their dirty coal
plant energy production. Only in the
summer season would there be surplus energy to possibly export to the USA and a
large portion of that revenue would be lost to transmission fees.
No, none of this is good unless you live somewhere between
Yarmouth and Glace Bay. Having another
province finance your future electrical energy security must be a nice
feeling. Or maybe it just feels
weird. Not only that, Newfoundland
ratepayers are on the hook for 50 years of operations costs to deliver that
power to you – how sweet is that. Emera
and the Nova Scotia Utility and Review Board have wrangled for Nova Scotians
the one-sided deal of a lifetime but the deal may prove too one-sided for their
own good if they starve the Golden Goose to death.
If Ottawa and Emera Refuse Write-Offs
Taking the Net Earnings
chart above and adding back interest costs and Emera’s Return on Equity creates
a serious set of losses. Two things stop
this chart from looking far worse. First
is the absence in any way of the NL Government’s $4.0B equity – this is a
write-off Nalcor clearly can’t pay back.
Second is that the Province is on the hook to supply Nalcor the major
funds required to retire the $7.9B in project bonds – the company won’t get the
money from ratepayers therefore it must beg to Government to assume the debt.
Growing Annual Deficits
The Province will be
saddled with huge Muskrat costs if Ottawa and Emera don’t participate in the
write-offs. Firstly, the Province must
grapple with its $4.0B in lost equity: this failed high-risk gamble was made with
borrowed money that will be festering in the Public Accounts and growing heavy interest
every year.
Add to this the annual subsidy
to Nalcor to cover Muskrat’s losses on operations. Already deeply in debt, the Province must
borrow that money. Then the Government
must start borrowing more money to pay interest cost on the bonds obtained to
provide those subsidies.
As debt is set to be retired
inside Nalcor, massive new bonds must be taken out by Government until all
$7.9B of debt is eventually transferred to the Province. For the model, the exact schedule of bond
maturity dates is replaced by a simple linear 50yr x $158M/yr rate of debt
transfer – only the interest costs are shown below.
The chart below roughly
predicts the growth to Government’s annual deficit due solely to Muskrat. The burden begins at $500M annually. We may as well forget that it rises
exponentially. The Province is no
position to deal with this addition to the deficit and will be in dire straits
early in the first decade.
If Ottawa and Emera
participate in the full write-down, the picture is still a very problematic one
for the Provincial coffers as the interest costs on the lost $4.0B equity will
still be due. Given the present state of
finances, even this component alone is not realistically ever going to be paid
off by the Province.
Ottawa May be Liable for $12.7B
It is essential to the
survival of the Province that a financial restructuring of the Muskrat project
take place as early as possible. The
Federal Loan Guarantees must result in the debt being fully taken on by
Ottawa. Emera must bow out of its equity
stake. The Province must write-off it’s
project equity. This is all just the
start.
Barring miraculous
unforeseen windfalls, the Province is still mired in a debt crisis from which
escape on its own appears impossible. It
is foreseeable that Ottawa will be compelled to bail out the $4.0B in debt
attributable to Muskrat.
In negotiating with
Emera and Nova Scotia, it is probable that Ottawa will, one way or another, fully
relieve Emera for its equity losses.
This adds up to Ottawa becoming
fully responsible for the entire capital cost of Muskrat simply because there
is no practical alternative. To defer
action and force Newfoundland into deeper losses will make the inevitable
Provincial bailout more expensive.
Ottawa and Nova Scotia Must be Held
Accountable
For this province, Muskrat appears to be an entirely worthless
asset. Only to Nova Scotia and Emera,
who have already completed the Maritime Link and are still dependent on coal
for about half their energy, does Muskrat offer any value proposition.
If Muskrat operations
are to carry forward, the existing contracts between Emera and Nalcor must be
completely revised to reflect the new reality.
Forcing Newfoundland ratepayers to bear the full cost of operations to
subsidize Nova Scotians is a nightmare scenario that will breed the worst
contempt imaginable.
Muskrat is a complete
and total financial wreck and only Ottawa has the capacity to clean it up. Given their gatekeeper role as project enabler
and strategic financier twice over, the result would appear deserving. They could never deny that they either knew
the risks and they should have fully understood that a day of reckoning could
likely come straight back to their door.
The question of whether
Muskrat Falls operates at all must largely depend on a major renegotiation with
Emera and Nova Scotia to pay their fair share of operating costs and
liabilities in proportion to the energy they intend to take. If Nova Scotia and Emera are intent on saying
a deal’s a deal and inflicting misery upon Newfoundland, this Province should
simply abandon Muskrat entirely and pull the plug. There may be nothing left to lose at that
point.
The tragedy of Muskrat
was a purely political act of creation.
It must be political action that corrects it.